Chapter 15 Working Capital Management 481The payables deferral period is found as follows, again using cost of goods
sold in the denominator because payables are recorded at cost:
Payables (^)
deferral period
!
Payables
Purchases per day
!
Payables
Cost of goods sold/365
15-4
! __$150,000
$1,013,889/365
! 54 days
GFI is supposed to pay its suppliers after 40 days; but it is a slow payer, delaying
payment on average until Day 54.
We can combine the three periods to calculate GFI’s actual cash conversion cycle:
Cash conversion cycle (CCC)! 90 days # 90 days " 54 days! 126 days
GFI’s actual 126-day CCC is quite different from the planned 80 days. It takes lon-
ger than planned to sell merchandise, customers don’t pay as fast as they should,
and GFI pays its suppliers slower than it should. The end result is a CCC of 126
days versus the planned 80 days.
When the planned 80-day CCC is “reasonable,” the actual 126 days is too high.
The CFO should push salespeople to speed up sales and the credit manager to
accelerate collections. Also, the purchasing department should try to get longer
payment terms. If GFI could take those steps without hurting sales and operating
costs, the! rm would help its pro! ts and stock price.
Two professors, Hyun-Han Shin and Luc Soenen, studied more than 2,900
companies over a 20-year period. They found that shortening the cash conversion
cycle resulted in higher pro! ts and better stock price performances.^5 Their study
demonstrates that good working capital management is important.
(^5) See Hyun-Han Shin and Luc Soenen, “E" ciency of Working Capital Management and Corporate Pro! tability,”
Financial Practice and Education, Fall/Winter 1998, pp. 37–45.
Some " rms are able to operate with zero or even negative
net working capital. Dell and Amazon.com are examples.
When customers order computers from Dell’s web site or
books from Amazon, they must provide a credit card num-
ber. Dell and Amazon then receive next-day cash, even
before the product is shipped and they have paid their own
suppliers. This results in a negative CCC, which means that
working capital provides, does not use, cash.
To grow, companies normally need cash for working
capital. However, when the CCC is negative, growth in sales
provides cash rather than uses it. This cash can be invested in
plant and equipment as well as research and development
or used for any other corporate purpose. Analysts recognize
this point when they value Dell and Amazon, and it helps the
companies’ stock prices.
SOME FIRMS OPERATE WITH NEGATIVE WORKING CAPITAL!
SEL
F^ TEST De" ne the following terms: inventory conversion period, average collection
period, and payables deferral period. Explain how these terms are used to
form the cash conversion cycle.
How would a reduction in the cash conversion cycle increase pro" tability?
What are some actions a " rm can take to shorten its cash conversion cycle?